Enerpac Tool Group Corp

NYSE:EPAC

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Enerpac Tool Group's Fourth Quarter Earnings Conference Call. During this presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, September 26, 2019.

It is now my pleasure to turn the conference over to Barb Bolens, VP, Corporate Strategy, Investor Relations. Thank you, Ms. Bolens, you may begin.

[Barb Bolens, VP of Corporate Strategy and IR]

Thanks, Dona. Good morning everyone, and thank you for joining us on our fourth quarter 2019 earnings conference call. On the call today to present the company's results are Randy Baker, President and Chief Executive Officer; Rick Dillon, Chief Financial Officer. Also on the call with us today are Fab Rasetti, General Counsel; Bryan Johnson, Chief Accounting Officer; and Bobby [indiscernible], Director of Investor Relations and Corporate Strategy.

Our earnings release and slide presentation for today's call are available on our Web site at enerpactoolgroup.com in the Investors section. We are also recording this call and we will archive it on our Web site.

Please go to slide two. During today's call, we will reference non-GAAP measures such as adjusted profit margins and adjusted earnings. You can find a reconciliation of non-GAAP measures to GAAP in the schedules to this morning's press release. We would also like to remind you that we will be making statements in today's call and presentation that are not historical facts and are considered forward-looking statements. We are making those statements pursuant to Safe Harbor provisions of Federal Securities Law. Please see our SEC filings for the risks and other factors that may cause actual results to differ materially from forecast, anticipated results, or other forward-looking statements.

Consistent with how we have conducted prior calls, we ask that we follow our one question one follow-up practice in order to keep today's call to an hour, and also allow us to address questions from as many participants as possible. As a reminder, we are now reporting continuing operations financial results following our announcement in July that we have reached an agreement to divest the EC&S segment. As a result, all financial information reported to-date, including fiscal 2020 guidance will be in the continuing operations format.

Now, I will turn the call over to Randy.

[Randy Baker, President and CEO]

Thanks, Barb, and good morning everybody. We are going to start today on slide three, but before I review the quarter and the full-year results, I want to announce one of the most pivotal events in our company history. This week, we officially launched the Enerpac Tool Group, and the new stock symbol EPAC, which is clearly symbolic of our new company name and commitment to the tool industry. This is the culmination of multiple years of hard work to transform Actuant into a top-performing, pure-play tool company and to set the stage for our future.

Enerpac is a premium brand with 110 years of history providing high-precision, reliable, and safe products to a demanding industry. Our new company serves both the light and heavy industrial tool market spanning a total servable customer base of over $8 billion. This provides ample space for organic growth and strategic acquisitions, while delivering superior margins, cash flow, and ultimately shareholder returns. We're a company focused on four product families, 14 tool categories, and serving 13 vertical industries. The breadth of our product coverage in serving the industry creates an environment for stable growth and lower cyclicality.

The four tool categories include general industrial, bolting technology, hydraulic pumps, and lifting systems, which are the focus of our product development and acquisitions. The general industrial tool area has the widest variety of applications, including aerospace, power generation, manufacturing, and many more. Bolting technology is also carrier of [ph] growth, and in the past two years we have increased market share through new products and increased marketing. Lastly, hydraulic pumps and lifting systems have always been a cornerstone of Enerpac through their commanding market share and innovation. The Enerpac Tool Group is a market leader, and will never compromise on our efforts to supply the highest quality and precision tools in the industry.

Now, moving over to slide four, Enerpac is a high-quality business comprised of three sales categories; Industrial Tools & Service, which is comprised of rental operations and manpower. Our strategy to deliver growth above market conditions remain consistent for the company, given the breadth of our product line and participation widely in the 13 vertical industries we're well-positioned for continued organic growth. More than 80% of our sales emanates from the high margin tool and rental sales, which provides an excellent platform for profitability.

Second, our investment in new product development is beginning to yield results in the form of higher sales contribution and is approaching our goal of 10%. Lastly, our effort over the last three years to create a more effective sales force for serving of more than 2,000 dealers worldwide has been successful.

From an operations perspective, the Enerpac Tool Group is comprised of 13 manufacturing locations positioned to serve local markets, and with any company, the key to our success starts with our engaged and dedicated employees committed to delivering the highest precision and quality tools in the industry.

As I've stated in prior earnings calls, our capital allocation priorities have not changed. We're firmly committed to invest in organic growth, maintaining a strong balance sheet, and making strategic acquisitions, which reside in the tool growth plans; and lastly, we'll return capital to shareholders through opportunistic share buybacks, which we achieved in our fourth quarter through the purchase of over 1 million shares. We'll provide more clarity into our long-term growth strategy during our investor day later this year. However, we are consistent in our approach of achieving organic growth, maintaining world-class operations, making disciplined acquisitions, and strict adherence to our capital allocation strategy.

Now, turning over to slide five. Our fourth quarter demand was weaker than expected, impacted by the developing global economic uncertainty. Our dealers are becoming more conservative, driven by slower retail demand. Secondly, the fourth quarter was impacted by our efforts to reduce low margin service sales, which we announced as part of our IT&S restructuring earlier this year, and the seasonally lower Middle East market. As a result, core sales declined by 3% in the quarter. While the lower sales volume impacted the quarter, our adjusted operating margin maintained steady versus last year.

EPS was also flat to last year, and both results were driven by actions we took to restructure the business, reduce our costs, and deploy cash to reduce interest expense. Our restructuring actions, which we initiated in the third quarter, will improve our cost position and positively impact detrimental margins going forward, should the economy continue to slow. Lastly, we are taking swift actions to reduce inventory to align with the lower volume expectations.

Now, turning over to slide six, our fiscal 2019 was a very successful year in terms of growth, profitability expansion, and execution of our portfolio rationalization strategy. Core sales grew by 4% with solid performance from most product lines and regions. Operating profit increased by 190 basis points, with a very high incremental margin of 102%. The higher profitability translated to EPS growth of almost 50%, bringing us one step closer to our long-term objectives.

2019 was our best new product introduction in many years. We released more than 30 new products to the market, which further advanced us towards our 10% contribution goal. Our strategic objective of delivering growth above the prevailing market condition was achieved through our intense sale focus and commitment to new product introductions.

As I earlier stated, the launch of the new Enerpac Tool Group is the culmination of our portfolio strategy execution. During the year, we sold two smaller business in preparation for the Engineered Components & System Segments sales. We are continuing the separation process, and we remain confident the sale closure will occur in the calendar fourth quarter of 2019. Overall, we're very pleased with the continued progress towards becoming a top-performing pure-play tool company.

And now, I'll turn the call over to Rick Dillon to go through the details on the quarter, and I'll come back with a market update and our guidance. Rick?

[Rick Dillon, CFO]

Thanks, Randy, and good morning everyone. So let's take a deeper dive into our justice fourth quarter results. Just a quick note that a reconciliation of the one-time item is excluded from our adjusted results has been included in the appendix.

So, if you turn to slide seven, fiscal 2019 fourth quarter core sales decreased by 3%. Tools and service sales were down 4%, partially offset by growth in the Cortland medical business. The impact from the stronger dollar reduced net sales by an additional 2%.

If we turn to slide eight, tools and service core sales declined 4%. It is comprised of flattish core tool products, a low to mid-single digit decline in service, and a double-digit decline in heavy lift products.

In North America, our largest region, product sales demand decelerated during the quarter and ended up flat to prior year, and this is in line with the U.S. manufacturing indicators. We believe our distributors are being more cautious on inventory levels due to the uncertainty of market conditions.

Product sales in Europe were down low to mid single-digits as Brexit and other geopolitical issues weighed heavily on demand. The rest of the world was also relatively flat. Service was down 3%. But the largest driver being the strategic access we took earlier this year to exit are less profitable, more commoditized North American service work.

The top line impact was a little stronger than anticipated as we exit these activities during the quarter, but the impact on profit was favorable. As expected, the large service projects that drove significant oversight service growth this year were completed in a third quarter and contributes to the fourth quarter year-over-year and sequential decline.

Heavy lift sales were also down in the quarter as we just continued the large custom products. These declines were partially offset by pricing, which covered the impact of tariffs and other commodity costs. We launched 7 new products in the quarter, bringing the full-year total to over 30. As Randy mentioned, we continue to get closer to our target of 10% of sales from products introduced to last few years as we ended the year over 7%.

As noted on slide seven, despite the reduction in core sales our adjusted operating profit held steady. So let's walk through the key drivers turning to slide nine. As expected, the North American service strategic exits and restructuring provided an immediate benefit to operating profit, partially offsetting other market-driven volume declines.

Pricing, net of tariffs and other non-commodity costs increases was slightly positive as far as other costs activity in the quarter, the benefit from reduced incentive compensation expense offset lower productivity, increased medical costs and lower bad debt recoveries in the current quarter. The decremental profit margin on the sales volume decline was approximately 13%, reflecting the service strategic exits, and the elimination of the lower heavy lift custom projects work. Continuing operations includes the 13 million ECS corporate costs, excluding these costs or operating profit margin for 2019 would be approximately 14%.

If you turn to slide 10, the overall adjusted EBITDA story for the quarter is essentially the same as operating process, so we won't spend any time here.

And moving on to slide 11, adjusted EPS for the second quarter was $0.21 in line with last year. Tax expense was lower than expected, primarily as a result of lower European earnings than expected, driven by core sales declined and resulting in lower GILTI tax.

Slide 12 is our normal segment slide, because we are reporting continuing operations only we just included this for compatibility purposes, so we won't cover this slide.

Slide 13 is our core sales trend for ITS. We have broken out tools, heavy lifting, and service. The tools product trend continues to be relatively stable, and we have seen more fluctuations from both service and heavy lift. We'll provide more information on historical product and service performance for the new Enerpac Tool Group at our Investor Day coming up.

Turning now to liquidity on slide 14, we generated $50 million of cash during the quarter, which was well below our expectations, the key drivers being the lower EBITDA and higher primary working capital for both continuing and discontinuing operations. We also saw increased cash restructuring as we accelerate the timing of some of our planned actions.

For the full-year, we generated $27 million in cash reflective of the fourth quarter miss. On a year-over-year basis, increased EBITDA and primary working capital improvements from our continuing operations was offset by the large tax refund from the Viking planning received last year, increased cash compensation costs from the fiscal 2018 bonus payout, and essentially no stock option proceeds in the current year.

All of these combined with approximately $30 million left cash from the ECS business during the year and $9 million in cash divestiture costs drove the year-over-year cash flow reduction. ECS had lower EBITDA, increased working capital, and increased capital expenses. Primary working capital for the ECS business increased $15 million year-over-year. These balances are subject to a post-closing working capital true-up that could potentially result an increase in the sales proceeds.

Working capital management for our continuing operations will remain the area of focus. We ended the year with higher than anticipated levels, specifically in inventory. We anticipated cash flows for fiscal 2020 to be between $50 and $75 million. This guidance range assumes a $10 million to $20 million reduction in working capital. The impact of lower cash taxes and interests will offset cash restructuring and other divestiture charges. CapEx for next year is expected to be approximately $10 million.

So we ended the quarter with $211 million of cash on hand after buying back just over 1 million shares of stock at a cost of 22 million and prepaying another 14 million on our term loan. In fiscal 2019, we paid down the term loan approximately $72 million, both all in line with our capital allocation for it priorities as we manage our balance sheet and opportunistically return capital to our shareholders. Our leverage continues to trend down and now sits at 1.7 times versus 1.9 times in Q4 2018. Our balance sheet condition provides us with a lot of flexibility to continue to execute our growth strategy.

Before I turn the call back over to Randy, I will walk through the key assumptions behind our fiscal 2020 guidance. With the ECS divestiture as well as some of the strategic exits we are planning in a fiscal year. We are providing a little more detail here.

First, I'll look at our sales walk on slide 15. The strong dollar seems to be staying with us for this foreseeable future, so we will see a negative impact from the average rate from last year. In addition to the impact from strategic exit of our lower profitable service in North America, we have identified several other non-core product lines we will be exiting during the year. As we discussed last quarter, these product offerings are each relatively small, and they have a negative impact on our overall profit margins. These products include sub-sea connectors, strand jacks and tie rack cylinders. We expect to complete these divestitures in the front half of the year and have completed one so far.

Collectively, strategic service and product line exits will reduce sales by about $50 million for the year and have a positive impact on operating profits. Using these two changes to anchor the fiscal '20 starting point, we will guide what we see core sales performance for the ongoing business for 2020.

We are expecting the tools market environment to be flat to down low single-digits with markets performance similar to our fourth quarter. Our NPD and commercial actions will continue to allow us to outperform the market by approximately 200 basis points. We also expect a service market environment to be flat to down low single-digits. The oversized service projects we had in fiscal '19 are not expected in fiscal 2020, which will be the primary driver of the overall decline. This will get us to a sales range of $575 million to $600 million for the year.

If we move on to Slide 16, we are expecting a 200 basis points improvement in EBITDA margin in fiscal 2020. The improvement reflects the impact of our strategic decisions on operating margins. We also are anticipating that approximately $9 billion of the $13 million ECS corporate costs remaining and continuing operations will either be reduced by recovery from the TSA or actions taken throughout the year as those services are no longer needed.

So this assumes $4 million of costs will impact the first quarter and the balance of the costs will be offset or eliminated through the balance of the year. From an EPS perspective, we have made the assumption that cash proceeds from the ECS transaction will be used to pay down the term loan after closing the transaction, reducing interest expense for the year.

With that, I'll turn the call back over to Randy.

[Randy Baker, President and CEO]

Thanks, Rick. So moving over to slide 17, the general economic drivers changed substantially in the fourth quarter. Growth rates in the major markets, including the U.S. and Europe have reached an inflection point. GDP and PMI indexes are shifting to lower growth rates, which is projected to continue through the near future.

Additionally, industry surveys are reflecting a more conservative outlook resulting in lower inventory and retail forecasts. Vertical industries impacted by these dynamics include industrial maintenance, on and off highway vehicle repair and general manufacturing, civil construction, aerospace, and oil gas continue to be healthy, although at a lower growth rate.

Rick has fully covered the core sales projections. So I'll move on to the guidance summary on Slide 19. 2020 full-year guidance is based on the new structure of a new Enerpac Tool Group. As Rick covered our projections for 2020 include the strategic access, which has an approximate $55 million impact, but increases profitability, which I want to stress if increases profitability.

As a result, the sales will be in the range of $575 million to $600 million. Our projected EBITDA will be in the range of $94 million to $204 million and EPS will be in the range of $68 million to $81 million. Cash flow is expected to be in the range of $50 million to $75 million and our first quarter range will be in $135 million to $144 million with EPS of between $0.08 and $0.12 of share. Our objective in 2020 is clear. We will continue to execute our tool company strategy, while systematically improving the operating performance of the Enerpac Tool Group with our ultimate goal of achieving a 20% plus EBITDA margin.

I'd also like to thank all of our employees and distributors worldwide for their continued commitments delivering the highest quality tools and services in the industry. So operator Donna, let's open it up for questions.

[Operator]

Thank you. [Operator Instructions] Our first question is coming from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.

[Jeff Hammond, KeyBanc Capital Markets]

Hey, good morning, everyone.

[Randy Baker, President and CEO]

Good morning, Jeff.

[Rick Dillon, CFO]

Good morning.

[Jeff Hammond, KeyBanc Capital Markets]

So, I really wanted to just understand a little bit better the cadence of these, you know, the $55 million of exits, how do they flow through, and I think you mentioned, it sounds like you're selling the product lines or you sold once, maybe just clarify, and then, just also touch on the service comps, the down five to nine, and I don't know if there's particular quarters where you have, you know, particularly tough comps, just trying to flesh all that out? Thanks.

[Randy Baker, President and CEO]

Okay. Well, Jeff, let me cover some of the broader strategic issues surrounding the exited product lines, because as we predicted internally that this would result in many questions from investors, so I'm going to try to cover it from a strategic standpoint first and then I'll hand it off to Rick to go through some details on the financials.

As we structurally changed to the Enerpac Tool Group, as I mentioned in the prepared remarks, we sold two small businesses prepared for the EC&S sale, and then the remnants of the original energy sector and also some remnants of the original component manufacturing company needed to be dealt with as well, and so as we talk through the strategic decision to limit our service revenue and particularly in very low margin aspects, and we talked about that in our third quarter, and that has a very positive impact. You saw that, of of $2 million of sales coming out in the quarter, the flow through was under 50%. So, we picked the right stuff not to do, and I think it's an important thing that we're running a business for profitability, not for fun, and we intend to continue that.

So, secondly, when it comes to the divested product lines, the first one I'll talk about is the connector business. The sub-sea connectors was a remnant of the original energy company, and it is a business which provides repair systems for sub-sea pipelines, and inherently it's a very complex business and one that is so far away from our tool strategy that it had to be dealt with, and unfortunately over time that had not been particularly profitable. So that's one. Number two is our Milwaukee Cylinder Company, which goes back many years, and as a component manufacturer in tie rod cylinder manufacturing, it has been part of the Actuant Group for a long, long time, and has been part either of the ECS business or in the industrial tool business due to the convenient manufacturing, but largely, it's never made much money, and it had to be dealt with in terms of moving it out of the group and establishing it out of our revenue stream. The final one is really a company called Uni-Lift or a product line called Uni-Lift, which is simply an adaptation of a screw jack system and as a component. And again, that was also part -- its manufacturing location was in the Milwaukee Cylinder. And so, when you bundle all that together, it was the final steps that we needed to make to complete the formation of a really high-quality tool company. Although painful, it was the right thing to do.

So, I'll turn over to Rick to provide a little more insight into the financials that you had questions.

[Rick Dillon, CFO]

Sure. So, for the $55 million, we said about $25 million of that is service. That activity in terms of exiting is largely behind us, and so we expect to see that starting right away in Q1. From a comps perspective, if you look at last year, Q2 and Q3 is where we had the large project revenue coming through. So, if you think about that, as well as the North American service top line going down, that's where you're going to particularly have the strongest impact in terms of tough comps.

From a non-core product perspective, those products, I think we mentioned one was complete -- we expect all of them to be completed in the front-half of the year, either in our Q1 or early in our Q2. That revenue comes with very low, and in some cases no profitability, so there's little impact on EBITDA, but from a top line perspective, that's about $30 million, and that'll show itself mostly in the back-half, but a little bit in Q2.

[Jeff Hammond, KeyBanc Capital Markets]

Okay, great. And then just kind of getting back to some of the slowing in theIT&S business, it sounds like Europe is a little heavier, but maybe just talk about end markets and geographies where it feels a little bit heavier or conversely more resilient?

[Randy Baker, President and CEO]

Jeff, what we saw in the quarter was -- in the early quarter, when the new tariffs were announced and some other issues that had developed around the world, there was an almost immediate reaction with order rates, and that wasn't just the U.S. market, it was in parts of southern Europe. And as we progress through the quarter, things improved, and we saw a distinct increase in order rates.

So, the reality is that the market feels like it's slowing in parts of Southern Europe. We've seen some issues in some of the Northern European countries that have been slowing. During my last dealer visits just a few weeks ago, I was on multiple different job sites in Europe as well as several distributors. And from a civil wind energy side, there is still a lot of activity out there. The amount of new wind farms going offshore in Europe is significant, which we're playing a big part of, but from a general manufacturing, if you look at vehicle repair and vehicle assembly to the extent that we ship into those markets, those are definitely on the weaker side.

In the U.S. market, certainly we've seen fluctuation in onshore bolting, which is really surrounding some of the onshore oil, gas, but on the good side, the power gen, nuclear and wind energy has been fairly strong. So, again, we see a little bit of a mixed bag, and one of the things I wanted to continue to stress on the two major markets, U.S. and Europe, is that we do participate widely in 13 verticals, which really provides a lot of potential customers and locations to sell to. So, the fact that we've improved our sales and marketing and coverage has helped that a great deal.

Now, when you shift into Australia and into Latin America, where mining plays a bigger role, we've seen some slowing in mining, but obviously they still have large fleets of equipment and processing mills that need to be maintained, and we've done fairly well in those markets. Now, China and Asia is another story. There have been a very distinct slowing effect in that part of the world, and we all know why that's occurring.

So I think as we look forward into our forward projection that we laid in there, on the distinct tool side of the business, the down three to up about 1% I think is a forecast that feels right at the moment, and I don't see an instance where we should be calling it down mid single-digits, but I do think the potential for some decremental sales in 2020 is certainly there.

[Operator]

Thank you. Our next question is coming from Allison Poliniak of Wells Fargo. Please go ahead.

[Allison Poliniak, Wells Fargo]

Hi guys. Good morning.

[Randy Baker, President and CEO]

Hi, Allison.

[Rick Dillon, CFO]

Hi, Allison.

[Allison Poliniak, Wells Fargo]

Just on the sort of, I guess, expanding the sales commentary, it sounds like there had been a little bit of an inventory build, any color do you feel like the inventory systems pollinated [ph], or it's just sort of overall macro concerns that's driving some of the weakness right now?

[Randy Baker, President and CEO]

Well, the inventory side from our tools company is actually a number that is quite manageable. It's directly resulted from the wholesale miss in our fourth quarter and, as number that we can work through and we plan to work through in our first quarter. One of the unique things about the Enerpac Tool Group and I think we've probably discussed this with investors openly before is that our wholesale to retail chain is actually quite short, many of our distributors do not stock large quantities of our product because our catalog is quite extensive and there are products that they do inventory that turn quite quickly. So if you looked at the average turn ratio of the dealers I'm very familiar with, they're going to have a turn rate of up between six and as high as 10 in some cases.

So, in that context that the items that they're stocking, they're turning quickly, the things that they're not stocking, we're able to supply from our warehouses either in Europe or in the U.S. quite quickly. And so you see that immediate inventory build in our part, but we can respond and work it through quite effectively over the next quarter. So that's the plan right now, certainly it's the thing to watch as we go through our first quarter and making sure we aligned with that, which are all significant cash associated with the inventory draw down and that's something we'll definitely report on an Q1.

[Rick Dillon, CFO]

So, just adding a little more there, when you think about our year, obviously the fourth quarters, the biggest star quarter on the tools side, and as we saw things decelerate quickly, really starting in July, we had inventory positioned for that, our actual estimates for the quarter. So we ended up, we planned it in August with more inventory, but we've already to Randy's point, it's the inventory that is moving, and we've already kind of set the plan in place to drive that working capital back to levels that we would expect for the business. So don't have a whole lot for any concerns today on our ability to get the inventory under control, just the nature of the business but we did end high and have plans to drive that back to a normalized level.

[Allison Poliniak, Wells Fargo]

Great, thanks. That's helpful and then just on your 2020 guidance, are you once again assuming sort of in certain net positive price impact in there as well?

[Randy Baker, President and CEO]

Slightly positive, slightly positive.

[Allison Poliniak, Wells Fargo]

Perfect, thank you.

[Randy Baker, President and CEO]

Thank you.

[Operator]

Thank you. Our next question is coming from Mig Dobre of Robert W. Baird. Please go ahead.

[Joe Grabowski, Robert W. Baird]

Good morning, everyone. This is Joe Grabowski on for Mig this morning.

[Randy Baker, President and CEO]

Good morning.

[Joe Grabowski, Robert W. Baird]

Good morning. I guess just another question on fourth quarter demand trends, you mentioned in North America, product sales demand decelerated during the quarter, could you just talk a little bit more about that rate of deceleration in the future seeing things stabilized here in September and again, you said you're comfortable with your core sales guidance. But you know, what is the risk if, if demand continues to decelerate?

[Randy Baker, President and CEO]

Well, we watch our daily order rates quite closely. And it's one of the things that is very well organized with the Enerpac Tool Group is we have very tight visibility to our wholesale, our backlog of products and which plant it's scheduled to come from. And so as we watch those daily order rates, we're comfortable what we're seeing early on. And as I mentioned, as we walked through the quarter, there was a very strong reaction in the first two months of the quarter of our quarter four followed by a rebound in the final months of the quarter. And I think as people got their mind around the fact that the new tariffs and a lot of the political environment that was going on in Europe was going to settle down that they went back to work. And so we're watching it very closely. But I do believe that our forward forecast is correct as we know it today.

[Joe Grabowski, Robert W. Baird]

Got it. Okay, thanks. And then circling back again on the strategic exits, the $55 million of strategic exits. I'm just curious will those actually be sort of backed out sort of like negative, negative acquired sales out of the core sales calculation or will there sort of be a core sales calculation and then an adjusted core sales calculation like an adjustment on the waterfall chart, but actually the reported core sales will be less than that less than the guidance that was provided if that makes sense.

[Randy Baker, President and CEO]

So we'll always -- will going forward will show a report core sales on an equivalent basis to the guidance. These strategic exits, we will adjust out of our core sales number that we give you. And we'll try to be clear with that even in our reporting. So, just like we did on these bridges, we'll start with the strategic exits, and then we'll go forward with what we call the really the go forward business and the core activity there.

And then just a little more color on the strategic exits, when you look at product, that product number which is $20 million or $30 million that will happen somewhat evenly over the quarters, the service number will be about the same until Q3 with Q4 being the lowest piece of that. So that gives you some kind of spacing on how you'll see those year-over-year drops.

[Operator]

Thank you. Our next question is coming from Deane Dray of RBC Capital Markets. Please go ahead.

[Deane Dray, RBC Capital Markets]

Thank you. Good morning everyone.

[Randy Baker, President and CEO]

Good morning.

[Deane Dray, RBC Capital Markets]

I was hoping you could go through the expectations regarding stranded costs after the EC&S sale. Yes, the pace of ramping down, where's corporate costs today? And what should it look like on the exit either mid-year, next year or year-end?

[Randy Baker, President and CEO]

Sure. So we started talking about last quarter the $17 million of "ECS stranded costs". What we've assumed in the guide is we'll have a fourth quarter close of the transaction. That means business is usual, will incur about $4 million of costs that would otherwise be allocated to the ECS business. For the remainder of the year, we've assumed that $9 million we will either get directly imbursement from through the transition services agreement and as those services are no longer required, the costs will either go down naturally or we'll take the actions to eliminate those costs.

So, from a year perspective, where last year we reflected $13 million of those ECS costs, we expect only to see $4 million for the year included in the continuing operations. As far as corporate costs, as we talked last call, we've got restructuring activity. We're working through those for a standalone company, we still have opportunities from a corporate perspective, but you still see in our guide roughly $30 million of corporate costs, which is basically flat to last year, as we continue to migrate through the TSA, we'll be able to take some of those structural moves that align our corporate structure to a smaller business.

So it will come out of the $13 million we expect by the end of the year, it's fully gone. And by the end of the year, we'll be in a position as that those services start to start to level set on our corporate structure. And should there be charges associated with that, we will announce them on a go-forward basis. But right now, the guide assumes $30 million and $4 million of stranded ECS costs.

[Deane Dray, RBC Capital Markets]

That's really helpful detail. And then if we just circle back on the 2020 look, maybe next layer of detail on what you're basing the market growth on, is this bottom up by your 13 verticals, how did you land at that range, and then the basis for the 200 basis of outgrowth that you're expecting?

[Rick Dillon, CFO]

So what we always do, Dean is we start with a bottom-up forecast to gauge from a country manager all the way to a region of what they believe that the markets going to look like. We also look sequentially at the run rates of orders and look at those trends of where those order rates have landed. And then third, I look at the macro economics, I spend a lot of time on the macros coming out of the mineral industries, industry for a long time, you've had to do that. And I've kind of carried that forward with this company. And when you bring those all together, you start looking at it from a corporate standpoint, where we think it's going to be from a macro. And then as you build it up from the bottom, you can see it from their level. And then you come to the middle where we've landed. So then you think about okay, how do you beat the market by about 200 basis points, what were the elements of a company that's capable of doing that? And over the past three years, we build a pretty effective sales force now.

We have sales goals down to a salesman level all over the world. We know who achieves, we know, where we have weak areas. For the first time ever, we really started working through our distribution development and where we have blank spots. So we're our capability of dealer support, dealer development, channel expansion as well as sales is better as good as it's been in a long, long time. And then when you've got an array of new products coming out, and I can name a lot of companies that do extremely well in that regard, new products will help balance a soft market because it builds excitement and the desire from your customers that helps offset that. So when you pull all that together, that that's how we expect to outperform. And we've shown that we can do that.

[Operator]

Thank you. Our next question is coming from Ann Duignan of JPMorgan. Please go ahead.

[Ann Duignan, JPMorgan]

Hi, good morning.

[Rick Dillon, CFO]

Good morning, Ann.

[Ann Duignan, JPMorgan]

If we went back to slide 13, where you have the breakdown of tools, heavy lifting and service, we put that into a pie chart looking into 2020, what is the mix of the ongoing business?

[Rick Dillon, CFO]

Just a second, we're flipping pages. I think it's about the same as we turn to appendage.

[Ann Duignan, JPMorgan]

Yes, but what this is like quarter just is it what 20% service, 10% heavy lifting and the rest is tools, is that right?

[Rick Dillon, CFO]

We talked about it in terms of products and the 75% products and 25% service revenues.

[Randy Baker, President and CEO]

Ann, if you refer to the chart on slide 4, which was really the profile of the business today. And so 73% roughly is all product sales, including the Cortland business. So 73% are generally high margin products. Now there are certainly the real product which is within Cortland is lower margins, but the medical side of that is definitely categories is a high margin product, but the remainder is all high value, high margin tools. The other piece I want to point out is that within our service revenue, we have this thing called rental. And we have a large tool rental fleet, which is quite profitable. And we ran it in two ways. It's the equipment, it goes out with our service reps. And it's a equipment that goes out to a customer that they're just simply going to rent from us that has a very, very attractive margin profile as well. So my comments in my opening statement is very true that the 80% plus of our revenue comes from product and rental that is quite high margin. And that's a very unique place to be. And it's something that one of the reasons why I believe our tool company now is well-positioned.

[Ann Duignan, JPMorgan]

Yes, that wasn't really my point. Randy, of the tools business reminds us also because so many things have changed. What percent of the tool business is direct versus distribution? Is it all distribution?

[Randy Baker, President and CEO]

Yes, high percentage is distribution. We have 2000 dealers with over 4000 points of sales. Of those 2000 dealers, they're going to address many, many verticals of the 13 that we talked about. We have essentially, I think we have between 15 and 20 company stores that will primarily be rental and service dispatch points. We did do a grand opening of our first full blown retail center in Deer Park, Texas, where we are actually running the entire Enerpac Tool portfolio through that store. And that's our test case of developing a true retail center. And the most important thing it's not in competition with our distribution, it's filling in white space that not necessarily is covered well and is also creates a very, very good supplemental service to distributors that surround that contiguous trade area.

I've seen it my tasks with other companies very effectively done. But I think the strength of our company really is always one, it has been in our distribution channels take in Enerpac 50 plus years to develop that strength in that channel. And something that gives us the ability to serve all those vertical industries.

[Ann Duignan, JPMorgan]

Okay, thank you. And remind us the mix geographically now in tools business overall?

[Rick Dillon, CFO]

About 50% North America, 30% Europe-ish.

[Randy Baker, President and CEO]

Yes, and the remainder is Latin America, Asia. Certainly we will provide the new fact sheets that will give the regional breakdowns for the investor day, but directionally that's about what it is.

[Ann Duignan, JPMorgan]

Thank you. Our next question is coming from Justin Bergner of Gabelli & Company. Please go ahead with your question.

[Justin Bergner, Gabelli & Company]

Good morning, Randy. Good morning, Rick.

[Randy Baker, President and CEO]

Good morning.

[Rick Dillon, CFO]

Good morning.

[Justin Bergner, Gabelli & Company]

I wanted to just better understand the businesses you're exiting, would it be possible for you to provide a specific EBITDA number or talk about, what would be your expected margin improvement if you don't exclude the $55 million of exits and looking at your fiscal year 2020 guide?

[Rick Dillon, CFO]

We won't do margin by product. But the $55 million as I mentioned came with little to no profitability. So if you look at the bridge, I think we have given up-cross bridge, the impact of exits. And so the…

[Randy Baker, President and CEO]

Just bear with us, Justin. We're trying to make sure we get to the right answer.

[Rick Dillon, CFO]

So there's very little profitability in there. And as we said, there's a 200 basis points improvement and that's largely driven by removing those sales, but no, no OP. That's really the basis without getting into EBITDA by product line. So that combined with the 13 million of year-over-year ECS costs we drive that improvement.

[Justin Bergner, Gabelli & Company]

Okay. So no OP may be a little EBITDAs sort of.

[Rick Dillon, CFO]

Yes.

[Randy Baker, President and CEO]

Yes, definitely.

[Justin Bergner, Gabelli & Company]

Okay. And then my other question was on cash flow, I mean, I understand that free cash flow in 2020 is making up for some of the shortfall in 2019, and you can adjust that for the working capital, but how much cash restructuring was in 2019 and in year 2020 guide, and then is the $10 million of CapEx a normal run rate, sub 2% of sales CapEx or is, should we think of something higher as we look out past this current fiscal year?

[Rick Dillon, CFO]

So, CapEx number is definitely a normalized number, and we don't foresee in the short-term any real drivers to get us anything, but that. When you look at cash restructuring, we kind of assumed maybe approximately 10-ish, 10 million for cash restructuring for the year and then about five was in 2019.

[Operator]

Thank you. [Operator Instructions] Our next question is coming from the line of Mig Dobre of Robert W. Baird. Please proceed with your follow up question.

[Joe Grabowski, Robert W. Baird]

Good morning, guys. It's Joe again. Thanks for taking my follow up. I wanted to ask about M&A, thoughts on M&A for the upcoming fiscal year. What's the pipeline look like and did you expect there'll be some M&A activity during the year or is fiscal year '20 going to be more of a year of kind of internal organization after the business sale?

[Rick Dillon, CFO]

Well, we've been working really hard to build the pipeline because what we wanted to do was be able to look at our product families be really investing on the organic growth side for last couple of years to get products coming out, but areas that we didn't feel we had the ability, the time or the expense of doing it internally. We've been building a pretty significant pipeline of M&A. So in 2020, you will see some M&A activity. I want to stress, we are going to be very, very cautious about it. We'll make sure that the company is at the quality that we want that's fits firmly within the verticals that we want, and that we believe really advanced not only our technology, but in fact brings in some either distribution or another aspect that can advance the company.

So we were actively working on it right now, but I don't want any investor to go away thinking that we're going to make a bad decision that would repeat something that they're worried about. And so I'm very disciplined on how we look at M&A, and I'm very picky on the types of companies. And quite honestly, if they're not on our worksheet of target businesses and product lines, I'm probably not interested. So just stick with us on this for couple quarters. You'll see more on that later on.

[Joe Grabowski, Robert W. Baird]

Great. I'm sure everyone is glad to hear that, and then if I can maybe just sneak in one last one. I'm sure this is going to be covered at the upcoming Investor Day, but I thought I'd just throw it out here. The 20% long-term EBITDA margin goal versus the 17% EBITDA margin guidance for fiscal year '20, what does it take to sort of capture those additional 300 basis points and maybe kind of how long will it take to get there?

[Randy Baker, President and CEO]

Well, if Rick is going to give you, it's kind of a walk and I'll just give you the top level view on that. We have felt and know very well that we can get to that 20%. We've operated there in the past The Enerpac Tool Group, if you recall back to Q3, is just Enerpac was in the mid-20s. So we know as we go through the transition services agreement, we exit those costs, which as Rick mentioned, there is $9 million of billable, there is about $4 million worth of sunk costs because it will be pre-closure, so that's a headwind that she can't really do much about in the short-term. But in the long-term, it's going with the transaction. And then, obviously it's going with the transaction. And then, obviously we look at the corporate expenses to align this company with the structure of a smaller business, which we're doing. And then as we've also been working through our actions in Q3, which was to take out unnecessary business functions in the tool company, was also prep work for that. So I hope I haven't taken everything away from Rick's comments, but I'll flip it over to him.

[Ricky Dillon]

No. It's a similar discussion and you're right, we'll go into this in more detail, but if you just look at the incremental 4 million, take kind of the midpoint of our guide, look at the incremental 4 million of savings from ECS. You look at full run rate savings of the 15 million of savings we talked about from the service restructuring. You look at the, Randy talked about streamlining and improving the operation of the Cortland business as well as exiting some of these non-core product lines. All of those things together will get us essentially to the 20%, but we're not done. And so that doesn't capture the taken a hard look at the corporate costs needed to run a business of our size and scale. So we believe clear line of sight to 20. The goal is to exceed that and we're collecting all of the actions we can state to your post-sale to kind of right size the structure of the organization.

[Randy Baker, President and CEO]

More to come.

[Operator]

Thank you. Our next question is coming from Justin Bergner of Gabelli & company. Please proceed with your follow up question.

[Justin Bergner, Gabelli & Company]

Oh, thank you for the follow-up. And most of it was answered in the prior set of questions, but in regards to the 20% target, it seems like you have confidence that you can do better than that because there was an expectation before that you could get to or close to 20% even inclusive of the 55 million of low profitability business that is being divested. Is that a fair conclusion?

[Randy Baker, President and CEO]

Yes. I think the 55 million was not an action required to get to the 20%. It certainly, it helps accelerate that. But as I said, and maybe if I'm being too blunt, we do not want businesses that don't make money. We will place them with strategic owners that can place them with similar businesses that can make money and it's better for the employee and it's certainly better for us. So, the 55 million was not a catalyst in order to get to the 20%. That 55 million helps us get beyond there and clearly sets the stage for the Enerpac Tool Group to be a truly high quality and pure play tool company. And sub-sea connectors are not tools, screw jacks for lifting systems for OEMs is not tools and tie rod cylinders are components that are sold to all sorts of suppliers all over the world that is not tools. It takes a management oversight. It takes cash and it takes investment to run those types of businesses. And as I said, on the divestiture of the other companies, if you cannot or unwilling to invest in it, you shouldn't own it. And so the monetization of those small businesses brings in some cash. And it helps make us a truly high quality tool company.

[Rick Dillon, CFO]

So, if you think back to Q3 similar questions on how we get to the 20%. At that point, fiscal 2019 includes three quarters in a couple of months of all 55 million, and we were able to walk you through the 20, so the 55 million coming out, doesn't - is it needed to get to the 20. It is reflective of how you get over the 20, and there is more actions we can take to exceed the 20 as well. So that walk I just did, didn't change from Q3 with the caveat that we can get even better just like we were at Q3.

[Justin Bergner, Gabelli & Company]

Okay. And then lastly on that service restructuring piece, I mean you've spoken about the 4 million, we can obviously add that back to the EBITDA guide, but the service restructuring piece, how much sort of flows over beyond fiscal year 2020, or how much of run rate is not captured in fiscal year '20?

[Rick Dillon, CFO]

Sure. There is about $8 million of it in our plan. We said 12 to 15, so you have $3 million to $4 million incremental that's not captured in '20.

[Operator]

Thank you. Our next question is coming from Ann Duignan of J.P. Morgan. Please proceed with your follow-up question.

[Ann Duignan, JPMorgan]

Yes, Hi, I'm surprised that everybody is so focused on the 20% EBITDA margin. I mean, I know it's an important metric for us to look at, but Randy, you also committed to $600 million in free cash flow by 2021, and we're sitting there, if you make the 2020 numbers will be at a 127 roughly. I mean, what's the lesson learned there? I mean, to me, that's much more important because that's money you could have allocated to growth or several purchases or whatever, and 20% margin on a much lower number is maybe not what investors we were expecting?

[Randy Baker, President and CEO]

So let's try to frame up our strategy going forward. So, in our Investor Day that will come up, we will give the profile of cash generation going forward. Now one point, very important thing to remember about the remainder of Actuant, the Actuant in its original state that where did the cash come from? A large percentage of it came from our tool group, very, very large percentage. And so, if you think about the numbers that we reported today and the numbers we reported last year in terms of free cash flow, and what we've just guided today, of between 50 and 75, the alignment of that is quite close. Now, as I've said, if we were to keep the ECS business and keep flowing forward to try to execute to a diversified industrial strategy, then we would have had to deploy significant amount of cash to those businesses that we retained, which was fundamental to the separation of the company and going through a pure-play tool business was that very fundamental strategy that we did not believe investing more in businesses that weren't going to have the same returns was unwise.

And so, that's why when you think about the strategy going forward and you do the modeling of the new Enerpac Tool Group, you wind up looking at a very compelling profile that says that you've now got a business as we reported today of liquidity of somewhere north of $200 million of cash on hand, a debt-to-EBITDA ratio of 1.7, margin profiles that at the final run rate, post separation that will be at or greater than 20%. Gross margin on all products that are extremely high, you can't say everything is above 50% because there is thesis [ph] with Cortland, but very high percentage of everything we sell is above 50%. There is very little that I can think about, if you are going to rate high quality companies of great balance sheet, great margin profile, less cyclicality, and a strategy on how to bring in strategic acquisitions and then have started to build a track record for organic growth, that's exactly how you want to run a company. So realized that it's a departure from the original strategy, but I think this strategy is going to deliver a much better TSR over the next 10-year profile.

[Operator]

Thank you. At this time, I'd like to turn the floor back over to management for any additional or closing comments.

[Barb Bolens, VP of Corporate Strategy and IR]

Thank you everybody for joining us today. As we mentioned in the call, we will be scheduling an Investor Day later this year, and we will be back in touch and send out the formal interpretation once we have solidified that date. Thanks again for your interest in the Enerpac Tool Group.

[Operator]

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time and have a wonderful day.